Scottish Mortgage Lifts The Lid On Unlisted Holdings

For years, Scottish Mortgage (LON: SMT) was the best performing investment trust and it remains extremely popular, even though its shares are down more than 50% from their all-time high. Baillie Gifford’s £12bn flagship fund aims to own and support the world’s most exceptional growth companies and is agnostic as to whether these are public or private.

Its unlisted holdings have created a huge amount of controversy in the last 18 months, not least because they have been rubbing up against the 30% upper limit at time of investment. Questions have been raised about the reliability of the valuations and the management skills in this area that have resulted in changes in the Boardroom.

Scottish Mortgage has now responded by publishing more information about its ten largest unquoted investments, giving revenue growth and margin details on an unnamed basis. There is also greater clarity about the valuation multiples, as well as the nature and timing of the changes for some of the individual stocks.

Healthy Growth

At the end of June the unquoted portfolio consisted of 53 private companies that accounted for 27.9% of total assets. Of these, the top ten represented about two-thirds of the unlisted exposure.

The fund’s most significant private companies are huge businesses, with the average equity valuation for the top 10 being $54bn. This would put some of them on a par with the largest listed global companies.

Revenue growth has been strong, averaging 38% in the year to the end of June 2022 and 164% over three years, or 57% if you exclude a star outlier. The gross profit margins have also been healthy coming in at 38% over the year.

This strong profitability enables these companies to re-invest to fuel future growth, with spending on R&D amongst the ten largest holdings equating to 56% of sales, compared to four percent for the global equity market. The picture is a bit “less healthy” in the unlisted stocks outside of the top 10, given that they are earlier stage.

Active Approach To Valuation

Baillie Gifford has an active approach to revaluing the portfolio and believes that it should be an up-to-date estimate given that investment trust shares are traded daily. This is radically different to traditional private equity funds, where there are significant valuation lags.

A third of the private portfolio is revalued each month, as well as on an ad-hoc basis for trigger events including: share price moves in publicly comparable stocks, changes in fundamentals, takeovers, IPOs and third-party transactions. The valuations are also reviewed in the light of the interim and final accounts.

During the 18 months to the end of June 2023, there were 871 revaluations performed on the 99 unquoted stocks held at various times in the period. Three quarters of the portfolio was valued five times or more.

The average movement in the valuation over those 18 months was -28%, which reflects an average decline in the private company valuation of 33%. Some of the strongly performing businesses were written-up, due to funding rounds being carried out above previous valuations.

Huge Potential

The largest unlisted holding at the end of August at 3.6% of the portfolio was SpaceX, which designs, manufactures and launches rockets and space craft. Elon Musk’s business also aims to improve global internet connectivity via its Starlink satellite network and has recently won a Pentagon contract to provide Starlink in Ukraine.

Just behind at 3.5% is Northvolt, a producer of sustainable lithium-ion batteries. The company is helping the shift away from fossil fuels, as it aims to produce the world’s greenest batteries by drawing on renewable energy sources and using recycled raw materials.

Another prominent holding is Brandtech, which invests in innovative companies building better, faster and cheaper tech-enabled marketing solutions for brands. It is well-placed to benefit from the growth in mobile usage and the impending AI revolution.

The broker Numis says that the extra information about the private holdings should give comfort to investors about the performance and the integrity of the valuation process. They believe that the 17% discount to NAV offers an attractive entry point to a unique portfolio that has the potential to deliver growth, even in a higher interest rate environment.